The United States Can’t Afford Prosperity

Earlier this week it was revealed that something remarkable and totally unexpected happened during the fourth quarter of 2012. The economy didn’t grow. It shrank.

“Real gross domestic product – the output of goods and services produced by labor and property located in the United States – decreased at an annual rate of 0.1 percent in the fourth quarter of 2012,” reported the Bureau of Economic Analysis on Wednesday.

What’s going on? Isn’t the economy supposed to be in full recovery mode by now?

The Federal Reserve, in a FOMC statement on Wednesday, said “that growth in economic activity paused in recent months, in large part because of weather-related disruptions and other transitory factors.”

Of course, blaming poor performance on the weather doesn’t work in most professions. Still, for the central bank to the United States government, excuses are the norm. Plus a flailing economy supports their program of creating $85 billion a month, from nothing but a ledger notation, to buy mortgages and treasuries. Additionally, it allows them to continue loaning out the money for practically free…the federal funds rate will remain between 0 and 0.25 percent.

Obviously, these are not the monetary policies of a recovering economy. They are the policies of an ailing economy. Somehow, these policies are supposed to make things better…

Improving Upon Graphs

The Federal Reserve’s compelled to print more money because their guiding Keynesian theory tells them more money will result in more spending, which will solve everything. More spending, they say, will result in an economic boom, resulting in more jobs…and, before you know it, everyone will grow richer together.

It doesn’t matter that QE, QE2, QE3, Operation Twist, and QE4 haven’t done a lick for the economy. The Federal Reserve’s distorted the economy far too much to stop now. They must keep pumping money until they bring about ultimate ruin. On the fiscal side, the Treasury must keep running $1 trillion deficits until their paper’s completely worthless.

Paul Krugman, Nobel Prize-winning economist and Keynesian par excellence, is even daring them on. On Tuesday, he told the folks at the The Daily Ticker that we don’t have to worry about the budget deficit now…that we should keep on spending.

Paul Krugman, of course, is a complete madcap. His days contemplating apparent aggregate demand insufficiencies and perceived supply gluts seems to have turned his brain to mush. All his time staring at these graphs while pondering possible government policies to make the graphs show what he wants has had the ill effect of transforming him into a moron.

In the pursuit of theory, Krugman’s forgotten one critically fundamental thing…how to think. He observes a GDP number that he deems is too low and he wants to improve upon where it shows up on the graph. He concludes that government stimulus, and artificially low interest rates, will boost up the GDP number. He also thinks the U.S. government can spend the economy to prosperity.

But there’s just one problem…

The United States Can’t Afford Prosperity

Unfortunately, the fiscal and monetary policies of the last five years have pushed the financial system and economy to the brink. Something must give…like the dollar or interest rates.

Here we’ll pause to let you in on an obvious, yet little known, secret: The United States can’t afford prosperity. What follows is an explanation…

Interest rate cycles span long periods of time…often they last between 25 and 35 years. U.S. Treasury yields reached a peak in 1920 and then slowly slid until the mid-1940s. Then, they rose again – along with inflation – and Franz Pick famously declared that “bonds are certificates of guaranteed confiscation.”

What Mr. Pick didn’t realize at the time of his declaration is that an inflection point had been reached. For in early 1982 yields again ventured over the mountain and slid down a soft slope to historic lows in December 2008. Since then, yields have skidded along the bottom…and the Federal Reserve is determined to keep them there.

But can they?

Perhaps they can keep yields on the 10-Year note around 2 percent as long as the economy slumps. But eventually, and in spite of the actions of government policy makers, economic growth will return. What’s more, when that happens inflation will return along with it.

Right now, the Federal Reserve’s promised to inflate its balance sheet by over $1 trillion per year until more people have jobs. Considering the money multiplier effect and the “magic” of fractional reserve banking, at some point, each $1 trillion added to the Fed’s balance sheet could translate into $5 trillion – or more – of money flowing into the economy.

All this new money flowing into the economy will drive up prices. Conversely, it’ll drive down the value of the dollar. Foreign lenders, like China and Japan, with massive holdings of Treasuries will demand higher compensation for holding a dwindling asset. In other words, interest rates will rise and payments on government debt will become completely unserviceable.

Any boost to GDP and increase in tax revenues will quickly be overwhelmed by the rising price of interest on government debt. So, in a most unfortunate way, the best scenario for the U.S. economy is slow, sluggish, lackluster growth. Anything more than that is simply unaffordable.